The Rise in Court Intervention in Transfer Pricing Disputes
There are more transfer pricing disputes making their way to court in Canada. Here, transfer pricing disputes have been primarily resolved through one of two methods: a request for Competent Authority assistance under the Mutual Agreement Procedure (MAP) of a treaty or by way of a Notice of Objection filed with the Canada Revenue Agency (CRA) in respect of the Notice of Assessment or Reassessment.
In circumstances where taxpayers cannot have their matter adequately resolved at the Notice of Objection stage, taxpayers have increasingly pressed their cases to the tax court of Canada for resolution. The tax court functions as a trial court, with all that implies. A taxpayer can appeal a decision of the tax court to the Federal Court of Appeal. A further appeal to the Supreme Court of Canada is possible. However, the taxpayer must first file a leave application and the Supreme Court may grant leave or dismiss the application.
The OECD Transfer Pricing Guidelines
It is important to keep in mind that Canada, as a member of the Organisation for Economic Co-operation and Development (OECD), fully endorses the OECD Transfer Pricing Guidelines. For instance, the Canadian taxing authority affirms that the arm's length principle should be the prevailing approach to transfer pricing.
Consequently, Canada's published administrative guidelines reflect the guidance provided in Chapter II of the OECD's Transfer Pricing Guidelines. In Canada, there is a preference for domestic comparables over foreign comparables. It is true, however, that foreign comparables are acceptable provided that such comparables meet identical standards of comparability. It is interesting to note that the CRA does use secret comparables for transfer pricing assessments but this is not the common practice.
Existing legislation and developments
It would be a mistake to conclude that in Canada the transfer pricing rules operate in a vacuum. Put simply, there are a number of sections in Canada's income tax legislation and regulations that deal with the tax treatment of intangibles, assets and expenses in relation to services. While Canada does not have specific legislation related to the transfer pricing of financial transactions, Canada does have rules related to thin capitalisation and, more generally, the tax treatment of financial transactions. Moreover, the federal government has proposed new rules that come into force in 2023 that are designed to limit the deduction of interest and are in line with the recommendations of the OECD's base erosion and profit shifting (BEPS) Action 4 Report. Canada has also introduced anti-hybrid rules that are consistent with the OECD's BEPS Action 2 recommendation.
An increase in audits
These recent legislative developments and the increasing number of cases heading to the courts point to the reality that the Canadian federal government is spending more resources on auditing transfer pricing activities and making it tougher on companies to meet compliance requirements. Now, it makes very good sense for companies involved in transfer pricing matters to be proactive on the defence front in order to ensure that if the CRA comes knocking with an audit, companies are properly and fully prepared to respond. This early audit protection approach has served our multinational clients exceptionally well and has effectively limited the time, cost and energy needed to respond to such CRA audits.
The COVID-19 pandemic may be one explanation as to why there has been an increase in audit activity by the Canadian taxing authorities. The financial ramifications of the COVID-19 pandemic continue to persist. For example, like many countries affected by the outbreak of the pandemic, the Canadian federal government increased spending to implement new measures to respond to the pandemic. Significant spending has, in turn, led to significant deficits. Some commentators have suggested that tax audits, and transfer pricing audits specifically, will be an area of focus for the federal government and the Canada Revenue Agency.
Originally published by Chambers Global Practice Guides.
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